Nine Economic Policy Disasters and What We Can Learn from Them

Richard S. Grossman

WRONG

Nine Economic Policy Disasters and What We Can Learn from Them

Richard S. Grossman

Description

In recent years, the world has been rocked by major economic crises, most notably the devastating collapse of Lehman Brothers, the largest bankruptcy in American history, which triggered the breathtakingly destructive sub-prime disaster. What sparks these vast economic calamities? Why do our economic policy makers fail to protect us from such upheavals?

In Wrong, economist Richard Grossman addresses such questions, shining a light on the poor thinking behind nine of the worst economic policy mistakes of the past 200 years, missteps whose outcomes ranged from appalling to tragic. Grossman tells the story behind each misconceived economic move, explaining why the policy was adopted, how it was implemented, and its short- and long-term consequences. In each case, he shows that the main culprits were policy makers who were guided by ideology rather than economics. For instance, Wrong looks at how America's unfounded fear of a centralized monetary authority caused them to reject two central banks, condemning the nation to wave after wave of financial panics. He describes how Britain's blind commitment to free markets, rather than to assisting the starving in Ireland, led to one of the nineteenth century's worst humanitarian tragedies- the Irish famine. And he shows how Britain's reestablishment of the gold standard after World War I, fuelled largely by a desire to recapture its pre-war dominance, helped to turn what would otherwise have been a normal recession into the Great Depression. Grossman also explores the Smoot-Hawley Tariff of 1930, Japan's lost decade of the 1990s, the American subprime crisis, and the present European sovereign debt crisis.

Economic policy should be based on cold, hard economic analysis, Grossman concludes, not on an unquestioning commitment to a particular ideology. Wrong shows what happens when this sensible advice is ignored.

WRONG

Nine Economic Policy Disasters and What We Can Learn from Them

Richard S. Grossman

Table of Contents

Contents Preface Prologue 1. Introduction 2. How to Lose an Empire without Really trying: British Imperial Policy in North America 3. Establish, Disestablish, Repeat: The First and Second Banks of the United States 4. The Great Hunger: Famine in Ireland, 1846-1852 5. The Krauts Will Pay: German Reparations after World War I 6. Shackled with Golden Fetters: Britain's Return to the Gold Standard, 1925-1931 7. Trading Down: The Smooth-Hawley Tariff, 1930 8. Why Didn't Anyone Pull the Andon Cord? Japan's Lost Decade 9. The Worst Financial Crisis Since the Great Depression: The Subprime Meltdown 10. I'm OK. Euro not OK? 11. What Have We Learned? Where Do We Go From Here? Bibliography

"let's hope that when the next major set of economic policy decisions has to be taken, politicians put aside ruling ideology and pick up a book like this." - Joel Campbell, International Affairs

"I have great admiration for this book. Grossman addresses an important question and his judgments are uniformly well reasoned and balanced. He is also an outstanding teacher of economics. ... Few economic historians can write as well as Grossman. But more of those who can write well should follow his example and write for policy makers and for the general public. If not economic historians, then who?" - Hugh Rockoff, EH.net

WRONG

Nine Economic Policy Disasters and What We Can Learn from Them

Richard S. Grossman

From Our Blog

Some good ideas take a long time to gain acceptance. When Adam Smith argued forcefully against tariffs in his 1776 classic The Wealth of Nations, he was very much in the minority among thinkers and policy-makers. Today, the vast majority of economists agree with Smith and most countries officially support free trade. Index investing, sometimes called 'passive investing,' has taken somewhat less time to gain acceptance.

A few weeks ago, I received an e-mail inviting me to sign a statement drafted by a group calling itself 'Economists Concerned by Hillary Clinton's Economic Agenda.' The statement, a vaguely worded five paragraph denunciation of Democratic policies (and proposed policies) is unremarkable ' as are the authors, a collection of reliably conservative policy makers and commentators whose support for Donald Trump appear with some regularity in the media.

Inspired by the 11 Tony awards won by the smash Broadway hit Hamilton, last month I wrote about Alexander Hamilton as the father of the US national debt and discussed the huge benefit the United States derives from having paid its debts promptly for more than two hundred years. Despite that post, no complementary tickets to Hamilton have arrived in my mailbox. And so this month, I will discuss Hamilton's role as the founding father of American central banking.

have not yet seen Lin-Manuel Miranda's hit Broadway show Hamilton. I feel badly about this for three reasons. First, Miranda is a 2002 Wesleyan graduate, a loyal and generous alumnus who gave a great commencement speech in 2015 and remains solidly committed to the university. Second, the music and lyrics are, quite simply, amazing. Third, as an economic historian, it is heartening to see one of America's economic heroes make it to Broadway.

One of the issues that distinguishes Donald Trump from mainstream Republicans ' aside from his bigotry towards Mexicans, women, and Muslims'is his opposition to free trade, which has been a staple of Republican ideology since shortly after World War II.

It is hard to imagine two politicians that are further apart ideologically than Bernie Sanders and Donald Trump. Nonetheless, these two presidential candidates have a lot in common: their outsider status, their unrealistic fiscal plans, and a desire to punish foreigners for America's economic problems.

On 23 June, British voters will go to the polls to decide whether the UK should remain in the European Union (EU) or leave it in a maneuver the press has termed 'Brexit.' As of late April, public opinion polls showed the 'remain' and 'exit' sides running neck— and — neck, with a large share of the electorate still undecided. The economic arguments for remaining in the EU are overwhelming. The fact that the polls are so close suggests that a substantial portion of the British electorate is being guided not by economic arguments, but by blind commitment to ideology.

In the 1983 movie The Right Stuff, during a test of wills between the Mercury Seven astronauts and the German scientists who designed the spacecraft, the actor playing astronaut Gordon Cooper asks: 'Do you boys know what makes this bird fly?' Before the hapless engineer can reply with a long-winded scientific explanation, Cooper answers: 'Funding!' If an economist were asked, 'Do you know what makes this economy fly?' the answer, in one word, would be 'trust.'

Last month HSBC, one of the world's largest banks, decided not to move its headquarters from London to Hong Kong.The revelation that a company is staying put is usually not earth-shattering news. Nonetheless, HSBC's decision made headlines in Asia, Europe, and the US for three reasons. First, HSBC is the world's fifth largest commercial bank: it holds more than $2.5 trillion in assets and is exceeded in size only by four state-owned Chinese banks.

The Chinese New Year begins on 8 February, ushering out the year of the sheep (or goat, or ram) and bringing in the year of the monkey. People in China will enjoy a week-long vacation and will celebrate with dragon dances and fireworks. Given the financial fireworks emanating from China, this is a good time to briefly review some of the major economic news coming out of the Middle Kingdom.

Economists are better at history than forecasting. This explains why financial journalists sound remarkably intelligent explaining yesterday's stock market activity and, well, less so when predicting tomorrow's market movements. And why I concentrate on economic and financial history. Since 2015 is now in the history books, this is a good time to summarize a few main economic trends of the preceding year.

Seven years ago this month the federal funds rate'a key short-term interest rate set by the Federal Reserve'was lowered below 0.25%. It has remained there ever since.Lowering the fed funds rate to rock-bottom levels did not come as a surprise. The sub-prime mortgage crisis led to a severe economic contraction, the Great Recession, and Federal Reserve policy makers used low interest rates'among other tools'in an effort to revive the economy.

With elections just about a year away, Americans can expect to hear a lot about regulation during the next twelve months'most of it from Republicans and most of it scathing. Republican frontrunner Donald Trump typifies the GOP's attitude toward regulation.

t the conclusion of the mid-September meeting of the Federal Open Market Committee (FOMC), the Federal Reserve announced its decision to leave its target interest rate unchanged through the end of this month. Although some pundits had predicted that the Fed might use the occasion of August's decline in the unemployment rate (to 5.1 percent from 5.3 percent in July), to begin its long-awaited monetary policy tightening, those forecasts left out one crucial fact.

Unlike fine wine, bad ideas don't improve with age. One such idea is the Invest in Transportation Act, co-sponsored by Sens. Barbara Boxer (D-CA) and Rand Paul (R-KY), which would institute a temporary tax cut on profits brought back to the United States by American firms from their overseas operations and use the proceeds to fund investment in transportation infrastructure.

The next time you are slipping the valet a couple of folded dollar bills, take a good look at those George Washingtons. You might never see them again. Every few years, there is a renewed push for the United States to replace the dollar bill with its shiny cousin, the one dollar coin.

One of the most striking structural weaknesses uncovered by the euro crisis is the lack of consistent banking regulation and supervision in Europe. Although the European Banking Authority has existed since 2011, its influence is often trumped by national authorities. And many national governments within the European Union do not seem anxious to submit their financial institutions to European-wide regulation and supervision.

Once again, one of President Obama's major legislative initiatives is being battered by a hostile Congress. Only this time, it is not Republicans standing in the way of the Administration's plans, but the Democratic minority in the US Senate holding up the president's Trans-Pacific Partnership (TPP) trade deal. The TPP is an ambitious trade deal currently being negotiated between eleven countries: Australia, Brunei Darussalam, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, United States, Singapore and Vietnam.

On May 7, British voters will head to the polls to elect a new Parliament. If mid-April forecasts are correct, the formation of a government will be a bit more complicated than in elections past. The results of those elections will have important ramifications for the conduct of economic policy in both Britain and the European Union. For most of the last two centuries, British governments have been formed by one of the two major political parties of the time.

As long as rulers have needed money for the military, public works, or just to enrich themselves, they have relied on taxes. As Americans approach the dreaded April 15 income tax-filing deadline, it is worth considering some key facts about taxation. There are many different modes of taxation: individual income taxes, corporate profits taxes, capital gains taxes, property taxes, inheritance taxes, sales taxes, social insurance taxes, taxes on imports, and a whole host of government-levied fees that look and feel a lot like taxes.

The industrialized world is currently moving through a period of ultra-low interest rates. The main benchmark interest rates of central banks in the United States, the United Kingdom, Japan, and the euro-zone are all 0.50% or less. The US rate has been near zero since December 2008; the Japanese rate has been at or below 0.50% since 1995. Then there are the central banks that have gone negative: the benchmark rates in Denmark, Sweden, and Switzerland are all below zero. Other short-term interest rates are similarly at rock-bottom levels, or below.

Last month, the European Central Bank (ECB) announced its plans to commence a '¬60 billion (nearly $70 billion) of quantitative easing (QE) through September 2016. In doing so, it is following in the footsteps of American, British, and Japanese central banks all of which have undertaken QE in recent years. Given the ECB's actions, now is a good time to review quantitative easing. What is it?

Burdensome, costly, and'let's face it'just plain stupid government regulation is all around us. And even well-meaning, reasonably well-designed regulations can impose costs all out of proportion with their benefits.

In the weeks and months following the subprime crisis, a number of financial swindles have come to light. Perhaps the most famous of these was the Bernie Madoff scandal. Madoff ran a Ponzi scheme, in which he attracted money from individuals (and institutions) who were hoping that he would provide sound investment management and a healthy return on the funds entrusted to him. Instead, the money ended up in his pocket. The small number of 'investors' who did withdraw their funds from Madoff were paid with money from new investors.

Although the media hype is usually most frenetic during presidential election years, this season's mid-term elections are generating a great deal of heat, if not much light. By October 13, contestants in 36 gubernatorial races had spent an estimated $379 million on television ads, while hopefuls in the 36 Senate races underway had spent a total of $321 million. For those addicted to politics, newspapers and magazines have long provided abundant, sometimes even insightful coverage.

I have written about the dangers of making economic policy on the basis of ideology rather than cold, hard economic analysis. Ideologically based economic policy has laid the groundwork for many of the worst economic disasters of the last 200 years.

On September 18, Scots will go to the polls to vote on the question 'Should Scotland be an independent country?' A 'yes' vote would end the political union between England and Scotland that was enacted in 1707. The main economic reasons for independence, according to the 'Yes Scotland' campaign, is that an independent Scotland would have more affordable daycare, free university tuition, more generous retirement and health benefits, less burdensome regulation, and a more sensible tax system.

As an early-stage graduate student in the 1980s, I took a summer off from academia to work at an investment bank. One of my most eye-opening experiences was discovering just how much effort Wall Street devoted to 'Fed watching', that is, trying to figure out the Federal Reserve's monetary policy plans. If you spend any time following the financial news today, you will not find that surprising. Economic growth, inflation, stock market returns, and exchange rates, among many other things, depend crucially on the course of monetary policy.

By Richard S. Grossman What do the Irish famine and the euro crisis have in common? The famine, which afflicted Ireland during 1845-1852, was a humanitarian tragedy of massive proportions. It left roughly one million people'or about 12 percent of Ireland's population'dead and led an even larger number to emigrate. The euro crisis, which erupted during the autumn of 2009, has resulted in a virtual standstill in economic growth throughout the Eurozone in the years since then.

By Richard S. Grossman For the past half dozen years or so, the first Friday of the month has brought fear and dread to large portions of the United States. This heightened anxiety has nothing to do with the phases of the moon, the expiration of multiple financial derivatives, or concerns about not having a date for the weekend.

By Richard S. Grossman Because Europe accounts for nearly a quarter of the world's economic output, this question is important not only to Europeans, but to Africans, Asians, Americans (both North and South), and Australians as well. Those who forecast that the United States's relatively anemic five-year-old recovery is poised to become stronger almost always include the caveat 'unless, of course, Europe implodes.'

By Richard S. Grossman Russia's seizure of Crimea from Ukraine has left its neighbors'particularly those with sizable Russian-speaking populations such as Kazakhstan, Latvia, Estonia, and what is left of Ukraine'looking over their shoulder wondering if they are next on Vladimir Putin's list of territorial acquisitions. The seizure has also left Europe and United States looking for a coherent response.

By Richard S. Grossman Within months of being introduced in 2009, enthusiasts were hailing bitcoin, the digital currency and peer-to-peer payment system, as the successor to the dollar, euro, and yen as the world's most important currency. The collapse of the Mt. Gox bitcoin exchange last month has dulled some of the enthusiasm for the online currency.

By Richard S. Grossman Although the dollar has had no legal connection to gold since 1973, the gold standard continues to hold an almost mystical appeal for many politicians and commentators. The 2012 Republican Platform called for the creation of a commission to study the possible restoration of the link between the dollar and gold. When asked about the gold standard this summer, Sen. Rand Paul (R-KY), a potential 2016 Republican presidential nominee, replied: 'We need to think about our currency that once upon a time had a link to a commodity, and I think we should study it.'

Is it morbid or therapeutic to analyze the economic catastrophes of the past? What critical strategies can be imported from the realms of medicine and military history to the study of the current state of the economy? Richard Grossman, author of Wrong: Nine Economic Policy Disasters and What We Can Learn From Them, skillfully dissects the cadavers of economic policies.

By Richard S. Grossman 2013 was an eventful year from the perspective of economics. The US government was shut down for 16 days as ideologically-driven Republicans held the budget hostage in an effort to repeal the Affordable Care Act. Japan's new nationalistic government embarked on a bold, and so far largely successful attempt to revive the country's anemic economy.

By Richard S. Grossman Britain operated under the gold standard for nearly 100 years before World War I forced Britain — and many other countries — to abandon it. During that century, Britain was the world's military, financial, and industrial superpower.

By Richard S. Grossman In the early 1600s, the King of Sweden declared that copper, along with silver, would serve as money. He did this because he owned lots of copper mines and thought that this policy would increase the public's demand for copper'and also its price, making him much wealthier.

By Richard S. Grossman To what extent should economic and foreign policies be guided by ideology? Are politicians who remain committed to particular policy prescriptions principled representatives? Are they opportunists who ride the popularity of simple, easily explained idea into office?

By Richard S. Grossman The public has been so fatigued by the flood of appalling economic news during the past five years that it can be excused for ignoring a scandal involving an interest rate that most people have never heard of. In fact, the Libor scandal is potentially a bigger threat to capitalism than the stories that have dominated the financial headlines.